The Unintended Consequences of Regulation

 

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Why the cost of regulation might offset the benefits.

Conventional wisdom regarding environmental regulation is that its primary effect is to incentivize producers of goods to reduce the negative environmental impacts of their operations. In the economics profession, we say that environmental regulations are designed to internalize the external costs associated with production of goods. That is, some of the costs to society associated with the production of the things we want are not paid by producers. This results in more environmental harm that is theoretically optimal. Environmental regulations are intended to ensure that the full cost of the environmental damage done by the production of goods is borne by the producer.

While it sounds intuitive, there are many problems with this simplistic approach to the problem. The “optimal” level of pollution may not be calculable. Even if it is, we may not be able to design a policy to influence market behavior to fix the problem. Even if we can, the political system might introduce inefficiencies in the implementation of the policy such that the cure is worse than the disease.

Assuming away all these issues, there is another potential problem. The costs imposed on producers by regulation may not actually be borne by the producers themselves. Some of the cost of the regulation might be borne by the general public in the form of higher prices or reduced output. In fact, there is good reason to believe this is the case.

Though the federal government is required to measure the benefits and costs of all significant regulations, there are significant problems with the way this is done. According to an article published in Regulation magazine, agencies often count every possible second and third-order benefit of a regulation while counting only the most obvious, direct costs of the regulation. The result is that the “benefits” of the regulation outweigh the costs by orders of magnitude, by construction. It’s certainly possible that many regulations would pass the benefit-cost test, but putting a thumb on the scale doesn’t allow for an objective examination.

A concrete example of this “leakage” of costs from the intended producers to the general public is helpful. Consider the modern agricultural production system. It produces more food per labor hour, per farm, per dollar of inputs than it ever has. It feeds billions with much left over. However, there are concerns about the environmental impact of modern agriculture. Some of the oldest agricultural regulations go back to the 1940s and current regulations cover the effects of agricultural practices on water, air, soil quality and other environmental concerns.

Regulators’ attempts to mitigate these economic effects by requiring licenses, inspections, imposing fines and other enforcement mechanisms impose costs on agricultural producers. However, it is an empirical question whether these costs are borne solely by agricultural producers or also by consumers of the end product: food.

To investigate this possibility, I have recently written a working paper examining the effect of environmental regulation of agriculture on the share of income spent on food. Below is the abstract of the article:

Cost-benefit analysis of agri-environmental regulation is limited in the sense that it only examines the effects a single regulation will have on the public and polluters. Further, important mechanisms through which the public might bear part of the cost of regulation are not examined. This paper uses new data that allows for examination of regulation by a specific government agency on a specific industry to determine whether and to what extent relative food costs are affected by regulation of agriculture by the Environmental Protection Agency (EPA). The index allows for an examination of the overall effect of regulation, which is an important addition to the existing literature. Findings indicate that the costs of EPA regulation have not been borne solely by producers and that relative food costs would be lower now if EPA regulation had not increased over time.

The analysis indicates that the costs associated with regulation have more than offset the benefits of increases in agricultural productivity from 1976 to 2010. To put it a different way, if environmental regulation of agriculture had stayed at 1976 levels, spending on food would have been 7.9% of disposable income rather than 11%. While this might not seem like much, this estimate applies to the entire U.S. population. It is likely that those with low incomes, who spend a larger percentage of income on food, are more impacted by these regulations than those who spend very little of their income on food.

My main point here is that, though regulation is considered to be an efficient way of dealing with the problems we face in producing the things we need, there are important limitations and problems with the implementation of this approach. I have provided an example of this, which indicates that there are real, measurable unintended consequences associated with regulatory efforts to solve society’s problems.

Levi A. Russell is an Assistant Professor at the University of Georgia.

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